Sunday, February 08, 2015

Greek negotiations with the EU Germany

Greek Prime Minister Alexis Tsipras is refusing the latest tranche of help of financial assistance from the Troika (EU, ECB, IMF) because Greece is rejecting the ruinous austerity policies on which they are conditioned (Tsipras erklärt Euro-Rettungsprogramm für gescheitertSpiegel Online 08.02.2015).

Instead of the next tranche of bailout funds - 7.2 billion euros, due pending a suspended review - Greece's new government wants the right to issue more short-term debt beyond a current 15 billion euro threshold. It also wants 1.9 billion euros in profits from Greek bonds held by the European Central Bank and other euro zone authorities, something that was agreed previously.

With that as a bridge, Greek officials would then try to renegotiate payment of Greek sovereign bond debt, perhaps by extending payments, only paying interest and getting some respite on the budget surplus it is expected to run.

Tsipras will be appearing at the EU Summit on Thursday, which German Chancellor Angela Merkel will also attend.

Yanis Varoufakis, the new political rock-star Finance Minister, reminds everyone that the stakes are high (Gavin Jones, Greek finance minister says euro will collapse if Greece exits 02/08/2015):

"The euro is fragile, it's like building a castle of cards, if you take out the Greek card the others will collapse." Varoufakis said according to an Italian transcript of the interview released by RAI ahead of broadcast.

The euro zone faces a risk of fragmentation and "de-construction" unless it faces up to the fact that Greece, and not only Greece, is unable to pay back its debt under the current terms, Varoufakis said.

"I would warn anyone who is considering strategically amputating Greece from Europe because this is very dangerous," he said. "Who will be next after us? Portugal? What will happen when Italy discovers it is impossible to remain inside the straitjacket of austerity?"

Varoufakis and his Prime Minister Alexis Tsipras received friendly words but no support for debt re-negotiation from their Italian counterparts when they visited Rome last week. But Varoufakis said things were different behind the scenes.

"Italian officials, I can't tell you from which big institution, approached me to tell me they backed us but they can't tell the truth because Italy also risks bankruptcy and they are afraid of the reaction from Germany," he said.

"Let's face it, Italy's debt situation is unsustainable," he added, a comment that drew a sharp response from Italian Economy Minister Pier Carlo Padoan, who said in a tweet that Italy's debt was "solid and sustainable." [my emphasis]

The combination of rejected the latest tranche of assistance and Varoufakis' reminding Germany of the stakes here strikes me as an astute "good cop/bad cop" posture.

By rejecting the additional funds, it's a way to say to Europe and German voters in particular, "We not asking for charity, we want to take responsibility for our own fate." While at the same time saying to Merkel, "Hey, you'd better think through the real implications of forcing Greece out of the Union."

Michael Pettis writes about options for restructuring and reducing the debt in Syriza and the French indemnity of 1871-73 02/04/2015, and in the process reviews the history of capital flows from Germany to Spain that set the stage for Spain's debt crisis. Other "periphery" eurozone countries experienced a similar phenomenon in the years leading up to the crisis. Pettis seems to have an unwarrented faith in the anti-labor "reforms" that Merkel has been demanding. But his analysis is a useful explanation in other ways. He's particularly good in refuting the creditors' "moral" argument against the debtors, in which debt is viewed as a sacred obligation overriding all other concerns.

The reference to the "French indemnity" has to do with the massive French reparations paid to Germany in the aftermath of the Franco-Prussian War, which ended with the establishment of the German Empire under Wilhelm I. It produced a massive capital inflow from France into Germany in a short time:

To give a sense of the sheer size of this payment, usually referred to in the literature as the French indemnity, this was equal to nearly 23% of France’s 1870 GDP. Germany’s economy at the time, according to Angus Maddison, was only a little larger than that of France, so Germany was the beneficiary of a transfer over three years equal to around 20% of its annual GDP. This is an extraordinarily large transfer. I believe the French indemnity was the largest reparations payment in history — German reparations after WWI were in principle larger but I don’t think Germany actually paid an amount close to this size, and certainly not relative to its GDP.

Great for Germany, right? Not exactly:

From an “asset-side” analysis, as I discuss in my January 21 blog entry, the transfer of capital over three years from France to Germany equal to more than 20% of either country’s annual GDP would have had very predictable impacts — they should have been very negative for France, as Berlin expected, and very positive for German. In fact the actual results were very different. This is because there are monetary and economic conditions under which liability structure matters much more, and conditions under which it matters much less. Economists and the policymakers they advise are too quick to ignore these differences, perhaps because there is not as well-formulated an understanding of balance sheets in economics theory as in finance theory, so that when someone like Yanis Varoufakis proposes that there are ways in which partial debt forgiveness increases overall economic value, instead of merely creating moral hazard, worried economists often recoil in horror, while finance or bankruptcy specialists (and an awful lot of hedge fund managers) shrug their shoulders at such an obvious statement. ...

From 1871 to 1873 huge amounts of capital flowed from France to Germany. The inflow of course drove the obverse current account deficits for Germany, and Germany’s manufacturing sector struggled somewhat as an increasing share of rising domestic demand was supplied by French, British and American manufacturers. But there was a lot more to it than mild unpleasantness for the tradable goods sector. The overall impact in Germany was very negative. In fact economists have long argued that the German economy was badly affected by the indemnity payment both because of its impact on the terms of trade, which undermined German’s manufacturing industry, and its role in setting off the speculative stock market bubble of 1871-73, which among other things unleashed an unproductive investment boom and a surge in debt.

France's economy, on the other hand, was able to resume growth and was not devastated in the way Germany expected it to be.

When the euro was adopted, it meant among other things that individual countries could not impose capital controls, i.e., could not regulate the flow of money into and out of the country. German capital went to countries like Greece, Ireland, Spain and Portugal where it set off speculative bubbles that became devastating for the receiving countries once the crisis hit and money flowed back to Germany where it was considered safer. He makes the comparison to more recent capital flows from Germany to Spain:

It is hard to imagine that the amount of inflows into Germany from 1871 to 1873 could have been comparable to the inflows Spain experienced, but if anything they were actually smaller. Here is why I think they were. From 2000-04 Spain ran stable current account deficits of roughly 3-4% of GDP, more or less double the average of the previous decade. Germany, after a decade of current account deficits of roughly 1% of GDP, began the century with slightly larger deficits, but this balanced to zero by 2002, after which Germany ran steady surpluses of 2% for the next two years.

Everything changed around 2005. Germany’s surplus jumped sharply to nearly 5% of GDP and averaged 6% for the next four years. The opposite happened to Spain. From 2005 until 2009 Spain’s current account deficit roughly doubled again from its 3-4% average during the previous five years. The numbers are not directly comparable, of course, but during those four years Spain effectively ran a cumulative current account deficit above its previous 3-4% average of roughly 21-22% of GDP. Seen over a longer time frame, during the decade it ran a cumulative current account deficit above its earlier average of roughly 31-32% of GDP.

He goes on to emphasize how ridiculous it is for Germany to take a one-sided moralistic position that a debt is a debt and must be paid back and that overrides all other considerations.

Aside from the one-dimensional morality of it, Germany's position on Greek debt isn't realistic:

Syriza’s victory in Greece has reignited the name-calling and moralizing that has characterized much of the discussion on peripheral Europe’s unsustainable debt burden. I think it is pretty clear, and obvious to almost everyone, that Greece simply cannot repay its external obligations, and one way or another it is going to receive substantial debt forgiveness. There isn’t even much pretence at this point. This morning financial advisor Mish Shedlock, sent me (as a joke? as a sign of despair?) German newspaper Zeit‘s interview with Yanis Varoufakis entitled “I’m the Finance Minister of a Bankrupt Country”.

Even if the question of who is to “blame”, Greece or Germany, were an important one, the answer would not change the debt dynamics. It would take the equivalent of Ceausescu’s brutal austerity policies in Romania, which were imposed during the 1980s in order for the country fully to repay its external debt, to resolve the Greek debt burden without a write-down. Given that Ceausescu’s policies led directly to the 1989 revolution, which culminated in both Ceausescu and his wife being executed by firing squad, the reluctance in Athens to imitate Romania in the 1980s is probably not surprising.

Pettis argues that we should try to avoid seeing this crisis in primarily national terms, though he realizes that's how it's broadly perceived. He argues:

Above all this is not a story about nations. Before the crisis German workers were forced to pay to inflate the Spanish bubble by accepting very low wage growth, even as the European economy boomed. After the crisis Spanish workers were forced to absorb the cost of deflating the bubble in the form of soaring unemployment. But the story doesn’t end there. Before the crisis, German and Spanish lenders eagerly sought out Spanish borrowers and offered them unlimited amounts of extremely cheap loans — somewhere in the fine print I suppose the lenders suggested that it would be better if these loans were used to fund only highly productive investments.

But many of them didn’t, and because they didn’t, German and Spanish banks — mainly the German banks who originally exported excess German savings — must take very large losses as these foolish investments, funded by foolish loans, fail to generate the necessary returns. It is no great secret that banking systems resolve losses with the cooperation of their governments by passing them on to middle class savers, either directly, in the form of failed deposits or higher taxes, or indirectly, in the form of financial repression. Both German and Spanish banks must be recapitalized in order that they can eventually recognize the inevitable losses, and this means either many years of artificially boosted profits on the back of middle class savers, or the direct transfer of losses onto the government balance sheets, with German and Spanish household taxpayers covering the debt repayments.

The following is a bit surprising from someone who seems to be praising Merkel's neoliberal "reforms" (although he does quote Charles Kindleberger approvingly!):

I am hesitant to introduce what may seem like class warfare, but if you separate those who benefitted the most from European policies before the crisis from those who befitted the least, and are now expected to pay the bulk of the adjustment costs, rather than posit a conflict between Germans and Spaniards, it might be far more accurate to posit a conflict between the business and financial elite on one side (along with EU officials) and workers and middle class savers on the other. This is a conflict among economic groups, in other words, and not a national conflict, although it is increasingly hard to prevent it from becoming a national conflict. ...

The “losers” in this system have been German and Spanish workers, until now, and German and Spanish middle class savers and taxpayers in the future as European banks are directly or indirectly bailed out. The winners have been banks, owners of assets, and business owners, mainly in Germany, whose profits were much higher during the last decade than they could possibly have been otherwise[.] [my emphasis; earlier in the post he explains that he often uses "Germany" to represent northern eurozone countries, "Spain" for the periphery]

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